Bill Hwang used leverage from across global banks to build his family office into a whale with positions that may have topped $50 billion.

Then came the collapse, with more than $20 billion in holdings linked to his Archegos Capital Management liquidated in just days. That’s prompted warnings of losses at banks including Nomura Holdings Inc. and Credit Suisse Group AG, as well as speculation over whether other investors with high leverage could cause more market chaos.

It’s not the first time in recent months that banks have been stung from lending to their richest clients: Last year, Luckin Coffee Inc. Chairman Lu Zhengyao defaulted on $518 million of margin loans, while the pandemic selloff led to some brokers forcing their clients to put up more collateral against their existing debt.

More than 10% of the world’s 500 richest people have committed stock for a combined $163 billion, according to an analysis by the Bloomberg Billionaires Index based on the latest disclosures available. That represents almost a fifth of their public holdings, up from about $38 billion four years ago and double the pledges after last year’s market bottom in March, when 40 of the wealthiest had pledged shares, the data show.

“Since the Covid outbreak, central banks in different countries have been providing liquidity, so banks and brokers are more likely to lend more money to their wealthy clients to keep the business,” said Kenny Ng, a securities strategist at Everbright Sun Hung Kai Co. in Hong Kong.

For the ultra-rich, committing shares is common practice. And with tens of millions of dollars in fees at stake, it’s hard for banks to say no to a practice that typically has plenty of safeguards in place and represents only a fraction of the value of the pledged shares. Oracle Corp.’s Larry Ellison, Tesla Inc.’s Elon Musk and Masayoshi Son of SoftBank Group Corp. are among those who’ve been relying on it.

Leverage Lovers
Larry Chen, who lost more than $3 billion on Friday when his GSX Techedu Inc. dropped amid the equity sales, also had pledged shares, though a company representative said he paid off his loan in last year’s third quarter and hasn’t committed any stock since. His 5.1 million of pledged American depositary receipts for a $50 million loan would have been worth $162 million as of Monday’s close, down from $728 million at the stock’s peak.

Pledging shares is relatively safe in a bull market, when rising prices ensure the value of the collateral remains above that of the loan facility. But if equities fall, the borrowers may face margin calls and have to come up with funds to avoid defaulting or having to liquidate assets at depressed prices. That’s what happened with Hwang, whose family office is now at the center of the stock sales. In this case, he used obscure derivatives to build large stakes in companies.

Securing a loan against a mix of real estate and stocks can help the world’s rich cut borrowing costs, and more of them have looked to leverage their assets as they’ve sought lifestyle changes in the fallout from the pandemic, according to Paul Welch, founder of London-based lending broker largemortgageloans.com.

“We’ve seen more transactions for boats, jets and homes,” Welch said. “We’ve had many more inquiries over the past year than we would normally about people wanting to utilize their assets to get transactions.”

Committing stock is especially common in Asia, where state-owned banks dominate financial markets and high-growth companies need to find different sources of funding. In mainland China, where top shareholders in initial public offerings typically have their stakes locked for 36 months, the practice can help them get liquidity while maintaining their voting rights.

Along with China, Japan and India require pledgers to disclose their activity in a timely manner to keep track of the possible risks in the market, though that’s not true for most of countries.

Public companies in the U.S. are required to annually disclose any hedging of the firm’s shares by directors or senior executives. Most large companies ban the practice.

“In a bull market, share pledging can make the bets more lucrative,” Everbright Sun Hung Kai’s Ng said. “When the value of a stake goes up, the investor might be able to ask for additional loans to buy more stocks. But the risks are also doubling when the market turns volatile.”

—With assistance from Jack Witzig, Anders Melin, Alex Sazonov and Ben Stupples.

This article was provided by Bloomberg News.